Branch profits
exemption
April 2014
The new exemption
Historically it has been a basic rule of
UK corporation tax that a UK resident
company is taxed on its worldwide profits
wherever arising, including those of any
foreign branches. Credit relief is then
given against the UK corporation tax for
the foreign tax paid on the profits of foreign
branches.
Since 19 July 2011, UK resident
companies have had the opportunity to
elect for profits of their foreign branches
to be exempt from UK taxation. The
exemption will apply to the branch’s trading
profits, investment income connected with
the branch and chargeable gains.
A branch in this context is anything that
constitutes a “permanent establishment”
for UK corporation tax purposes. This
will usually mean any fixed premises
of the company that are located in a
foreign territory, although certain agency
arrangements can also be included even
where there is no physical presence.
The new branch profits exemption will
usually improve a company’s overall tax
position where the rate of foreign tax
is lower than the UK rate because the
taxation of branch profits will usually be
capped at the foreign tax rate, with no
additional UK tax being levied.
In addition, where the foreign tax rate is
higher than the UK rate, there may be an
administrative advantage in treating the
branch profits as tax-exempt, instead of
treating the profits as taxable in the UK
and then calculating the relevant double
tax reliefs.
Making an election
The exemption is claimed by making an
election. Once made, the election will
enable the total taxable profits of a UK tax
resident company to be apportioned
so that any profits genuinely allocated to
foreign branches of a UK company may be
excluded from UK corporation tax.
However, this also means that any branch
losses cease to be tax-deductible in the
UK.
A company can elect to be included within
the new regime at any time from 19 July
2011 and the election will apply to all
accounting periods starting after the
election is made. The election is on a
company by company basis, so different
companies in the same group may elect or
not as they choose.
The election must be on an “all or nothing”
basis for the company making the election.
This means that an election will apply to
all foreign branches of a company including
branches set up after the election is made.
It may be beneficial to hold any loss-making
foreign permanent establishments through
a separate UK company which does not
elect into the branch exemption, if further
losses are expected. In this way, UK tax
relief should be available in respect of
foreign permanent establishment losses.
A company may decide to enter the regime
at any time. However, the election must
be received by HM Revenue & Customs
before the start of the first period to which
it relates.
Once an election has been made, it is
irrevocable after the day on which the
company’s next corporation tax accounting
period was expected to begin.
How the exempt branch profits are
calculated
It is important that profits are allocated
fairly between the UK and the non-UK
sections of any company that has elected
for the branch profits exemption.
Generally, the profits are allocated to a
branch on the basis outlined in the relevant
double tax treaty between the UK and the
foreign country concerned or, if there is no
treaty, on the assumption that the OECD
model treaty is in place. The relevant
profits will be the profits that the
permanent establishment would expect to
make if it were a separate entity carrying
on its business at arm’s length from the UK
company.
Anti-avoidance
Provisions exist to prevent companies
attempting to inflate the profits of their
exempt branch to increase profits falling
outside UK tax. Certain expenses of the
company must be taken into account at
branch level when calculating the profits
of the branch. For example, any capital
allowances available on equipment used
at an exempt branch are assumed to
have been claimed by the exempt branch.
Transitional rules also exist to manage
profits of a branch moving from taxable to
exempt.
Losses
Where a branch incurred losses in any of
the six years prior to the exemption coming
into force, profits will become exempt only
after the tax losses of those branches in
the immediately preceding six years have
been matched by branch profits.
Currently all the branches looking back six
years and looking forwards are considered
in aggregate when working out whether
past losses have been matched with
subsequent profits.
However, it is possible to elect for the
branches in specified territories to be
streamed so that, for example, once all the
losses previously incurred in that territory
have been matched with profits from the
same territory, any future profits from that
territory will be exempt.
Excluded territories
If a branch is located in a country where
there is no double tax treaty with the
UK, the branch profits exemption is not
available for a foreign branch of a “small”
company. A small company is defined in
accordance with the EU commission
Branch profits exemption
guidelines as a company that: i) has less
than 50 employees; and, ii) an annual
turnover of less than, or equal to, €10
million or an annual balance sheet with
assets of less than, or equal to, €10
million.
Diversion of profits
There is no automatic exclusion of
branches set up in tax havens but there
are restrictions on the application of the
regime to branches in low-tax jurisdictions.
A low-tax jurisdiction is one in which the tax
liability is less than 75% of the
corresponding UK tax liability.
Where a branch is based in a low-tax
jurisdiction and the profits of the branch
exceed £200,000, it is necessary for the
company to demonstrate that the branch
does not exist for the purpose of avoiding
UK tax and it does not carry out
transactions that have the purpose of
avoiding tax. The details of the anti
avoidance rules are complex.
This exemption could be very valuable for
UK companies with overseas branches.
Even if there is no tax benefit, it may
reduce the administrative burden of
reporting overseas profits and claiming
UK tax relief. Due to the complexity of the
anti-avoidance rules, advice should be
taken before making an election. Please
get in touch with our team if you would like
to discuss whether your business would
benefit from the exemption.
Contact us
City
Devonshire House
60 Goswell Road
London
EC1M 7AD
T 020 7566 4000
Romford
Orbital House
20 Eastern Road
Romford, Essex
RM1 3PJ
T 01708 759759
Heathrow
Middlesex House
800 Uxbridge Road
Hayes, Middlesex
UB4 0RS
T 020 8848 5500
Redhill
Surrey House
36-44 High Street
Redhill, Surrey
RH1 1RH
T 01737 779000
St Albans
105 St Peter’s Street
St Albans, Herts
AL1 3EJ
T 01727 896000
West End
141 Wardour Street
London
W1F 0UT
T 020 7304 4646
www.kingstonsmith.co.uk
Views expressed in this article are those of the contributor. No responsibility for loss occasioned by any person acting or refraining from action as a result of the material in this newsletter can be accepted by the LLP or
any of its associated concerns. A member of KS International.